The parties remain divided on what the top tax rate should be and on whether fresh revenue should come from tax increases or only from economic growth.

The Senate's top Republican, Mitch McConnell of Kentucky, said yesterday in a statement that Republicans, who failed to gain control of the Senate, will meet Obama “halfway” in deficit-reduction talks because Democrats need “to move to the political center, which is where the work gets done in a divided government.”

The comments from Republican leaders marked the start of political positioning and negotiations over what to do about the so-called fiscal cliff, a combination of automatic spending reductions and expiring tax cuts that amounts to $607 billion in 2013.

Lawmakers in both parties say they want to avoid the recession-causing cliff, though each side is warning that it's the other party's intransigence that must end.

Former Republican aide Eric Ueland said Boehner's comments, which effectively called for reopening the deficit talks that he and Obama had in 2011, were “a reflection of the practical reality” that financial markets were looking for answers from Washington and “you can't let things drift.”

Deficit Negotiations

U.S. stocks tumbled yesterday, with the Dow Jones Industrial Average falling 312.95 points, or 2.4 percent, to 12,932.73 in its biggest drop since Nov. 9, 2011. Treasuries rallied, pushing 10-year note yields down by the most since May, on concern that lawmakers won't agree to defer the mandated spending cuts and tax increases, slowing the economy. The Dollar Index, which measures the greenback against six major trading partners, rose to a two-month high.

Until now, investors had been complacent about the impending fiscal cliff. An improving jobs market, a recovery in housing and gains in consumer confidence have boosted stocks and alleviated concern about the credit quality of U.S. government debt. Even with yesterday's moves, the Standard & Poor's 500 Index is up almost 11 percent in 2012 and 10-year Treasury yields, at 1.65 percent, are below the average over the past decade of 3.69 percent.

“At least from the congressional Republican end of things, they are going to move as quickly as they can and as fully as they can to be as clear as they can about what they want on the fiscal and tax policy side,” Ueland, who was chief of staff to former Senator Bill Frist when the Tennessee Republican was majority leader, said in an interview.

A Senate Democratic aide said that while Boehner's stated openness to revenue was promising, the details he mentioned — notably so-called dynamic scoring that would let Congress rely on revenue generated by the tax plan — weren't sufficient. The aide wasn't authorized to speak publicly about talks between party leaders.

The big question for Boehner is “how far is he willing to go” to reach a deal with Obama and the Democrats, said Alan Abramowitz, a political science professor at Emory University in Atlanta.

“Boehner is still going to be under a lot of pressure from the right wing,” Abramowitz said. “It is going to be interesting to see how he handles that in negotiations with the president on the deficit and the fiscal cliff.”

'Right Formula'

Republicans haven't altered their tax policy stance because they continue to believe it's right, said Representative Kevin Brady, a Texas Republican and member of the tax-writing Ways and Means Committee.

“We've always felt this was the right formula for both getting the deficit under control and growing the economy,” Brady said in an interview yesterday. “Fundamental tax reform, coupled with addressing the entitlement issues, could be an awfully strong step, an awfully strong signal to the market, that they can invest with confidence again.”

Brady said he thought that the idea of gaining additional revenue through economic growth was the common ground between the parties, and that Boehner and House Republicans were in sync. Republicans will also, as they did in 2010, point to continued economic weakness as a reason to avoid tax increases.

“This economy is flying so low and slow,” Brady said. “Turbulence from this fiscal cliff could send it into the ground and that makes no sense, for either party for any reason.”

Business leaders are impatient for some sort of deficit agreement to reduce the uncertainty affecting the economy, said John Engler, president of the Business Roundtable, a Washington-based group of chief executives.

“The committee chairs don't change, the leadership doesn't change, so what's the reason to delay? You know all the issues. Start making decisions,” said Engler, a former Republican governor of Michigan.

Fitch Ratings warned that the U.S. may be downgraded next year unless lawmakers avoid the fiscal cliff and raise the debt ceiling in a timely manner, while Moody's Investors Service said it will wait to see the economic effects if the nation experiences a fiscal shock.

Senate Majority Leader Harry Reid, a Nevada Democrat, pledged to use the chamber's expanded Democratic majority to push for a “balanced approach” to reaching an agreement.

Top Earners

Obama's re-election and Republicans' failed bid to take over the Senate majority showed that voters want higher taxes for top earners, Reid told reporters yesterday.

“The vast majority of American people — rich, poor, everybody — agrees: That the rich, the richest of the rich, have to help a little,” Reid said in Washington.

The majority leader offered to work with Republicans to reach consensus, saying he had a “pleasant conversation” with Boehner yesterday morning.

Democrats are “not going to mess with Social Security” as part of revisions to entitlement programs Republicans are seeking in exchange for revenue, Reid said, adding, “We're happy to deal with entitlements.”

Reid said he would oppose changes to the way benefit increases are calculated on an annual basis, an idea that had been discussed in previous bipartisan talks.

Vice President Joe Biden said the administration is prepared to work with the Republican leadership on “the two overarching problems right now,” the tax increases and automatic spending cuts scheduled to begin in January.

“There's all kinds of potential to be able to reach a rational, principled compromise,” Biden told reporters traveling on his plane yesterday.

Representative Peter Roskam, an Illinois Republican on the tax-writing Ways and Means Committee, pointed to Democratic divides over the income threshold at which tax increases should take effect and put it in contrast with the “clarity” among Republicans. “The area of common ground is you say, look, there's an opportunity to get more revenue to close these gaps,” he said in an interview. “But we believe that the revenue comes from growth.”

Boehner said negotiations between the parties should be held to avert the tax increases and spending cuts and that he would seek concessions from Obama.

“The president must be willing to reduce spending and shore up entitlement programs that are the primary drivers of our debt,” he said.

Obama has called for higher tax rates for individuals making more than $200,000 a year and married couples making more than $250,000. Boehner emphasized Republican opposition to raising income tax rates.

Bloomberg News

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